UK banking commission urges better standards

After a year which has seen major scandals involving rate-rigging, money-laundering and rogue-trading rock the UK's financial industry, an influential parliamentary committee recommended Wednesday that senior bankers should be held more accountable for their bank's actions. One measure, it said, should be a new criminal offense of "reckless misconduct"—one that could carry a prison sentence.

"The health and reputation of the banking industry itself is at stake," Andrew Tyrie, the chairman of the parliamentary commission on banking standards, said in a statement. "Many junior staff who may have done nothing wrong have been impugned by the actions of their seniors. This has to end."

Treasury chief George Osborne praised the commission on his Twitter feed, describing it as "impressive." He said the report would "help our plan for stronger safer banks."

The report, compiled by a panel which includes lords, lawmakers and the Archbishop of Canterbury, takes a scythe to the industry. It suggests changes that will make many a banker wince.

The committee argues that there has been a "misalignment of incentives" in the financial industry and that pay structure has become "dysfunctional." Because bankers are "paid too much for doing the wrong things," the report says, lapses of standards shouldn't be surprising.

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"Public anger about high pay in banking should not be dismissed as petty jealousy or ignorance of the operation of the free market," the report said. "Rewards have been paid for failure. They are unjustified."

Among many of the committee's recommendations is the creation of a code that defers bonuses for longer, and better aligns risk and rewards.

Again and again, the report demanded accountability, arguing that executives turned a blind eye so they would not be punished for what they could not see.

"Where they could not claim ignorance, they fell back on the claim that everyone was party to a decision, so that no individual could be held squarely to blame—the 'Murder on the Orient Express' defense," the report said.

"It is imperative that in future senior executives in banks have an incentive to know what is happening on their watch —not an incentive to remain ignorant in case the regulator comes calling."

Britain's financial community greeted the headline-grabbing aspects of the report with alarm. Gary Greenwood, an analyst with Shore Capital, expressed concern whether the industry would be able to attract top talent, given pay restraints and the possibility of jail time for "getting the job wrong."

"We think the proposal to put financial safety ahead of shareholder interests suggests an industry that is unlikely to generate above-average returns for its owners in the long run," he said.

The commission also addressed one of the biggest bank bailouts. Royal Bank of Scotland was rescued in 2008 with a 45 billion-pound ($71 billion) injection of state capital that has proved crippling to the British economy. The country's political leaders are anxious to return the bank, which is more than 80 percent owned by the taxpayer, to the private sector. But the timing, and therefore whether taxpayers will get their money back, remains up in the air.

The commission says that RBS continues to be weighed down by uncertainty over the bad assets it still holds and by having the government as its main shareholder.

It said the government should make a commitment to undertake a detailed analysis of whether or not to split off the bank's bad assets into a separate legal entity—known as the good bank/bad bank split. The governor of the Bank of England, Mervyn King, is among those who have argued that the losses for the taxpayer might be lessened if they were split, with the bad bank left with the state and unwound over time.

Osborne said that selling a share in RBS is "some way off," but announced the government will "urgently investigate" the case for breaking up RBS and creating a "bad bank" of risky assets.

In his annual Mansion House address in London on Wednesday evening, Osborne said that review will be swift and a decision will be made in the fall.

He confirmed that the government is "actively considering" options for selling shares in Lloyds —but did not set out a timeline for disposing of the government's 40 percent stake in the bank.

"Nothing better signals Britain's move from rescue to recovery than the fact that we can start to plan for our exit from government share ownership of our biggest banks," Osborne said.

The commission was backed by both houses of Parliament. Its recommendations will form the basis for legislative and other action.

The commission also urged the banks to honor the report's recommendations in letter and in spirit, hoping that in this way the institutions would earn public respect and build trust.

The report's authors felt the need to offer a more philosophical look in resolving the big issues. It argued that it was time to learn the lessons of the past.

"Banking history is littered with examples of manipulative conduct driven by misaligned incentives, of bank failures born of reckless, hubristic expansion and of unsustainable asset price bubbles cheered on by a consensus of self-interest or self-delusion," the report said. "An important lesson of history is that bankers, regulators and politicians alike repeatedly fail to learn the lessons of history: this time, they say, it is different."

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